How a vicious circle of self-interest sank San Bernardino

Editor's note: This is the first of two parts examining how San Bernardino sunk into a $45.8 million deficit, forcing the city to file for bankruptcy protection.

SAN BERNARDINO - When this sun-drenched town filed for bankruptcy protection in August, the city attorney suggested fraudulent accounting was the root of the problem.

The mayor blamed a dysfunctional City Council and greedy police and fire unions. The unions blamed the mayor. Even now, there is little agreement on how the city got into this crisis or how it can extricate itself.

"It's total political chaos," said John Husing, a former San Bernardino resident and a regional economist. "There is no solution. They'll never fix anything."

Yet on close examination, the city's decades-long journey from prosperous, middle-class community to bankrupt, crime-ridden, foreclosure-blighted basket case is straightforward - and alarmingly similar to the path traveled by many municipalities around America's largest state.

San Bernardino succumbed to a vicious circle of self-interests among city workers, local politicians and state pension overseers.

Little by little, over many years, the salaries and retirement benefits of San Bernardino's city workers - and especially its police and firefighters - grew richer and richer, even as the city lost its major employers and gradually got poorer and poorer.

Unions poured money into City Council elections, and the council poured money into union pay and pensions. The California Public Employees' Retirement System, or CalPERS, which manages pension plans for San Bernardino and many other cities, encouraged ever-sweeter benefits. Investment bankers sold clever bond deals to pay for them. Meanwhile, state law made it impossible to raise local property taxes and difficult to boost any other kind.

No single deal or decision involving benefits and wages over the years killed the city. But cumulatively, they built a pension-fueled financial time bomb that finally exploded.

In San Bernardino, a third of the city's 210,000 people live below the poverty line, making it the poorest city of its size in California. But a police lieutenant can retire in his 50s and take home $230,000 in one-time payouts on his last day, before settling in with a guaranteed $128,000-a-year pension. Forty-six retired city employees receive more than $100,000 a year in pensions.

Almost 75 percent of the city's general fund is now spent solely on the Police and Fire departments, according to a Reuters analysis of city bankruptcy documents - most of that on wages and pension costs.

In the dark

San Bernardino's biggest creditor, by far, is CalPERS, the public-employee pension fund. The city says it owes CalPERS $143 million; using a different calculation, CalPERS says the city would have to pay $320 million if it left the plan immediately.

Second on the city's list of creditors are holders of $46 million worth of pension bonds - money borrowed in 2005 to pay off CalPERS. The total pension-related debts are more than double the $92 million owed to the city's next 18 largest creditors combined.

Complicating matters were obscure budgeting procedures that left residents in the dark. The word "pension" doesn't appear once in the most recent 642-page budget, and retiree costs are buried in detailed departmental line items.

"I've been asking for years for the pension costs," said Tobin Brinker, a former council member and pension-reform advocate who lost his seat last year to a challenger backed by nearly $100,000 in contributions from the fire and police unions. "I still don't know the number."

Jim Penman, the longtime city attorney who critics say is closely aligned with the unions, alleged during a council meeting this summer that 13 of the past 16 city budgets had been falsified. He has refused to elaborate on that accusation since, but told Reuters that he hasn't retracted it, either.

The Securities and Exchange Commission has opened an informal inquiry into the San Bernardino situation because of the city's bond obligations. The U.S. Department of Housing and Urban Development, which has provided funds to the city in the past, says it is conducting a routine periodic audit of the city's books that began before the bankruptcy.

No regulatory or law enforcement agency has announced any criminal probe. Recently hired city finance officers do say they have found evidence of terrible accounting and record-keeping.

But unlike in the small Southern California cities of Bell, where eight city officials face trial on allegations that they stole from the public, and Vernon, where three officials have been convicted of corruption, San Bernardino's problems appear to be mainly the result of back-scratching on an epic scale.

It's a pattern common throughout the Golden State - and while the particulars are quite different, it is akin to what happened in other states with severe financial crises, such as Illinois and Pennsylvania.

'2.5 at 55'

By the time San Bernardino's council met behind closed doors on Sept. 17, 2007, it was already clear the city was in trouble.

Just six months earlier, a report by consulting firm Management Partners showed that spending was outpacing revenue, pension costs were escalating and the city was quickly accumulating unfunded retirement liabilities.

Last decade's housing market boom had papered over the deep economic problems stemming from the shutdowns of a huge steel mill in Fontana in the 1980s and Norton Air Force Base in the 1990s.

Now the boom was over. Tax revenues were poised for a big fall.

Between 2007 and 2011, they dropped 30 percent, according to Husing, the regional economist.

Yet on this day in 2007, the city was about to raise pension benefits again, in a deal allowing non-public-safety workers to retire at age 55 with a pension equal to three-quarters of their salary. Called "2.5 at 55," it calculated annual pensions at 2.5 percentage points of final salary for each year worked - 75 percent for 30 years.

It wasn't nearly as good a deal as the one police and firefighters enjoyed - a "3 percent at 50" plan passed a year earlier. That enabled the public-safety workers to retire at 50 with a pension of up to 90 percent of their final salary. Regardless, "2.5 at 55" was what union negotiators had asked for, and the council was poised to rubber-stamp it.

But then something happened. And in a city which has a particularly toxic brand of politics, what transpired depends on who you talk to.

According to four people present at the meeting, Penman brought a pregnant co-worker to the session. By their account, Penman's co-worker made an emotional case for an even more generous pension deal. Otherwise, she said, she would be forced to leave San Bernardino and seek work in a city with better benefits. She had her family to consider, she said.

Penman vehemently denies that any of this took place.

"Welcome to San Bernardino politics," he said.

Runaway train

That afternoon, in public session, the council unanimously voted to award its non-safety workers 2.7 percent at 55 - more even than the union sought. That tiny fraction could raise the pension on a $100,000 salary by $6,000 per year. Penman, in office since 1987, earned $164,799 last year, according to city payroll data.

"In hindsight I am not proud of this vote," said Brinker, who was on the council at the time. "The recession hit barely a year later. This was one more log on the pension bonfire."

Meanwhile, San Bernardino continued to boost wages along with benefits. The average salary for a full-time San Bernardino firefighter in 1997 was $75,610, adjusted for inflation into 2010 dollars. By 2010, it was nearly $147,000, according to a Reuters analysis of Census Bureau data.

City wages were a runaway train, according to the Management Partners report. The city charter automatically calculated police and firefighter pay using a formula linked to wages offered by comparably sized cities - most of which were much wealthier than San Bernardino. Efforts to amend the charter were strongly opposed by the safety unions and voted down by the council earlier this year.

City workers took advantage of compensation rules, common among public employees in California, that made retirement deals even better. Key to this was boosting an employee's eve-of-retirement wages, which form the basis of the pension calculations.

Mike Conrad, fire chief from 2006 to 2012, said he saw managers negotiate a promotion in their final year, to boost their final salary. It was not uncommon for someone to move into a position with a $30,000 annual pay rise shortly before retirement, he said.

Retiring employees are also able to extract big one-time "cash outs." In San Bernardino, eight hours per month of unused sick time can be rolled over and saved year after year, without limit. Come retirement, 50 percent of the total can be taken in cash. The same goes for unused vacation time: up to 460 accrued hours of vacation - nearly three months of salary - can be cashed in at the Fire Department, Conrad said.

The police have a similar deal. In 2009, patrol Lt. Richard Taack retired at age 59, after 37 years of service. He took home $389,727 that year, including $194,820 in unused sick time and $33,721 for unused vacation time, according to city payroll records. Shortly after Taack retired - on an annual lifetime pension of $128,000 - he was hired part time by Penman's City Attorney's Office, at $32 an hour.

Additional reporting by Peter Henderson and Jim Christie in San Francisco.